Adapting Central Bank Operations to a Hotter World

A large number of options are available to central banks to incorporate climate-related risks into their monetary policy operational frameworks, says this technical document from the Network for Greening the Financial System (NGFS).

Adapting Central Bank Operations to a Hotter World: Reviewing Some Options explains that climate change poses new financial risks to central banks’ monetary policy and that they have a responsibility to consider the effect of this risk on their operations. Central banks could also ensure “their monetary policy operations do not undermine the transition to a low-carbon economy and/or explore ways in which they can actively support that transition.”

The report analyses possible changes to central bank credit operations, collateral policies, and asset purchases, concentrating on the asset side of the balance sheet and liquidity instruments. Nine policy options were chosen for their relevance to multiple central banks and for their relationship to existing tools. These nine options were rated for monetary policy effectiveness, contributions to mitigating climate change, effectiveness as risk protection, and operational feasibility.

Policy options with the greatest climate impact include targeted credit operations, the positive screening of collateral, the alignment of collateral pools with climate targets, and the tilting of asset purchases – measures that would typically leverage market mechanisms.

In contrast, the most operationally feasible options include the adjustment eligibility criteria for counter-parties, the screening of collateral, and the screening of purchasable assets. The study also finds that central banks must make strategic decisions on risk tolerance, metrics, data and the balancing of trade-offs in order to act effectively on climate change. It also reveals that better disclosure of climate-related data is vital to support this action.

This NGFS report is a comprehensive research document with case studies, explanatory notes and extensive annexes, and received considerable publicity for encouraging the introduction of climate change considerations into monetary policy. It builds on an earlier and more rudimentary NGFS examination of climate change and monetary policy published in June 2020.

The NGFS is a network of 83 central banks and financial supervisors representing over 85% of global GNP and over 75% of greenhouse gas emissions.